June 1, 2015
By Dan Jamieson, Financial Advisor
Smaller broker-dealers are facing two divergent paths.
One path leads to a dead end, a route being followed by aging B-D owners who, faced with expanding regulatory costs, are looking to get out of the business. The other road, traveled by B-Ds looking to survive, offers opportunities to acquire advisors and assets from firms that exit the business.
“The sad fact is that a lot [of small B-Ds] won’t be around in a few years because they don’t have the money” to keep up with compliance costs, says Joel Blumenschein, president of Freedom Investors Corp. in Brookfield, Wis., which has about 75 reps.
The latest statistics from the Financial Industry Regulatory Authority show that the long-term decline among B-Ds continues. Through April, Finra had 4,040 member firms, down more than 14% from 4,720 in 2009.
As firms shut down, their reps will be looking for new homes, Blumenschein says—an opportunity for surviving B-Ds. To that point, Freedom Investors has more than doubled its rep count over the past three years amid the fallout.
When contacted by Financial Advisor magazine in May, Blumenschein had just received a message from a business broker, calling with “another [broker-dealer] looking to be bought,” he said.
“There are plenty of B-D sellers,” confirms Steve Chipman, chief executive at Foothill Securities Inc. in Santa Clara, Calif., a 230-rep broker-dealer. Because of regulatory burdens, sellers are just saying, “‘No mas,’” Chipman says.
Meanwhile, small firms that plan on sticking around are discussing how they might combine or merge some of their operations, he adds. “The fear is, you don’t want to be swallowed up,” he says. “There’s a lot of talk among firms like, ‘Hey, we’re not in trouble, but where could we fit together? What can we do together that would be accretive [to earnings]? Maybe we could keep one of the B-Ds, or combine the IAs.’”
Those kinds of discussions “have happened more in the last three years than ever before,” Chipman says.
Not everyone is convinced that smaller B-Ds will have to bulk up to build scale.
Tina Maloney, chairman and majority owner of Winslow Evans & Crocker Inc. in Boston, whose firm has about 50 employee advisors, gets calls from potential acquirers like everyone else.
“Everyone is for sale at some price,” Maloney allows, but unless B-Ds have substantial assets, “I just don’t see these very small firms being acquired,” she says. “There’s no sense purchasing a small firm without huge assets [and then] picking up all their compliance issues.”
Ray Grenier, chief executive at Bolton Global Capital Inc. in Bolton, Mass., is in the same camp. “I don’t lose any sleep over these [huge] firms combining all these [acquired] B-Ds, with the hope that it will work out,” says Grenier, who has 75 producing reps with assets of around $5 billion. “There’s not a compelling case for scale that we can see.”
Clearing costs for smaller firms are not much more than they are for larger competitors, Grenier says, occupancy expenses should be about the same, and payroll is equivalent or even lower for the little guys.
Larger firms may be able to spread out the costs of marketing and recruiting, but that advantage might be offset by the higher costs from supervising a lot of smaller producers, he adds. A three-man shop like Treece Financial Services Corp. in Toledo, Ohio would seem an obvious candidate to be bought out, but that’s not the case, says Dock David Treece, a partner at the firm.
“Our thinking is the exact opposite,” he says. “We’d be more apt to be buying than selling, because a whole generation of advisors is preparing for retirement.
“We’ve built a fairly robust compliance program given the narrow scope of our [broker-dealer] business,” which is limited to packaged products, Treece adds. “It seems to work fairly well. We’re able to address issues with regulators. We could probably roll up some small firms or reps into a system like ours.”
Buying producers in bulk through a transaction makes some sense, given that one-on-one recruiting is a tough game for small independents. Few can offer the incentives larger firms do, and advisors tend to prefer the perceived safety of larger operators, recruiters say.
Potential recruits worry most about small firms’ ability to pay for regulatory costs, fines and arbitration awards, says recruiter Jon Henschen of Henschen Associates LLC in Marine on St Croix, Minn. They fear that smaller dealers could be forced out of business or sold as a result of a regulatory screwup. “Larger firms can afford more mistakes,” Henschen says.
It’s easy to understand the concerns of advisors. Last year, fines imposed by Finra grew 125%, to $135 million, up from $60 million in 2013, according to the law firm of Sutherland Asbill & Brennan.
“The bar has certainly been raised by enforcement,” Chipman says. “What we’re seeing [industrywide] is that once an item goes to enforcement, it’s definitely game on. They’re in it to win.”
“We see regulators basically … looking for B-Ds to write big checks even for the most minor infractions,” Grenier says.
If the regulatory atmosphere gets even more intense, “We’d have to think very seriously” about dropping the B-D, Treece says. “There are a lot of services we can provide under a B-D, [but] the regulatory demands would be significantly less” without it.
Small Charm, Big Growth
Lest you think all the headwinds small broker-dealers face mean they can’t thrive, think again. “We’ve had a spectacular growth over the last five years,” Grenier says. “Our revenues are up two and a half times from 2009, and assets have almost tripled.”
His firm, Bolton Global Capital, recruits almost exclusively out of the wirehouses. The big traditional firms do many things that irk their producers and prompt them to leave, like cutting pay or consolidating offices, he says. “We can provide custom solutions the bigger firms can’t—for technology and compliance solutions with specific procedures,” Grenier says.
Like most smaller firms, Bolton Capital relies on word of mouth among advisors to attract the right kind of talent. “Last year was our best year ever for revenue and Ebitda,” says Don Bizub, chief executive at Western International Securities Inc. in Pasadena, Calif., a $60 million revenue firm.
He, too, is able to land some wirehouse reps by offering a personal touch. That’s something the head of a big firm just couldn’t do, he says. “It does make a difference, especially if you’re recruiting without writing huge checks [because] having a direct relationship with [management] might be very important” for some advisors.
“Firms that offer a really solid platform, individualized service, research help, business help and a real connection with people have a tremendous opportunity,” agrees Robert Seawright, chief investment officer and chief information officer at Madison Avenue Securities Inc., a San Diego-based firm with about 150 reps.
Seawright mentions that he recently spent a half hour with one of the firm’s brokers working out an issue with a client’s portfolio. That’s something he could never do in his past life as a successful Merrill Lynch rep, he says.
Access to key people is critical, says Henschen, who recruits for a number of small firms. Brokers wanting a new firm call him all the time because the “go-to people” at their broker-dealers are no longer there.
“For small firms, it’s more about service than services,” Henschen says, explaining that the best broker prospects for boutique firms don’t need or want the bells and whistles found at large firms.
Bizub, an industry veteran, says the business has never gotten any easier or less expensive. But instead of fighting against the ever-growing demands, he suggests that B-Ds just accept the changes and use technology to their advantage.
“You have to continue looking at what you’re trying to deliver, what the advisor experience is, and how to leverage that relationship with advisors in a way that a large firm just can’t,” he says.